Posted
by
Soulskillon Friday July 09, 2010 @12:43PM
from the hypocrisy-in-action dept.

An anonymous reader writes "Techdirt has the details on how it was possible for the last Harry Potter movie to lose $167 million while taking in nearly $1 billion in revenue. If you ever wanted to see 'Hollywood Accounting' in action, take a look. The article also notes two recent court decisions that may raise questions about Hollywood's ability to continue with these kinds of tricks. For example, the producers of 'Who Wants To Be A Millionaire' now have to pay $270 million for its attempt to get around paying a partner through similar tricks."

Jackson's contract is for a cut. What's crazy is, in hollywood everyone knows to ask for a cut of the *gross*, not net. I can buy the idea of magic rings, elves, dwarves, hobbits, dragons, ents, wizards, and so forth, but a net reported profit on a Hollywood movie? That's just fantasy.

A cut of the *gross* may not even work. If I'm reading the various blogs correctly, what the movie studios do is set up a new company for the production of each movie, lend that new company a ton of cash for the creation of the movie. The studio then has to get paid back before any net or gross calculations are performed because it's a loan repayment, not a cost of production. Since it's a loan, they also get to charge interest. Thus, with a big enough initial "loan" and corresponding interest rate, it's possible to rig things so that no movie ever turns a profit - regardless of the quality or box office draw./props for the creative way of avoiding payouts//still think it's equivalent to stealing

Peter Jackson had to sue New Line Cinema to get paid for LotR. New Line claimed they lost money on the trilogy.

Indeed [nytimes.com], on top of that I recall the Tolkein Trust [slashdot.org] suing New Line for hundreds of millions after New Line only paid them $62,000 for the rights to the movies. New Line apparently claimed that was 7.5 percent of the gross of the films. Isn't that the standard these days? (as the article notes)

It's been the standard for years, and it's been one of the things that really pisses me off, that while the MPAA is going after movie pirates claiming theft, their members have been stealing money from investors and the tax man for decades. Even where the contract stipulates a percentage of gross, dirty tricks have been used to screw over directors, actors and other investors. The only reason most of Hollywood's accountants and producers aren't rotting in jail for embezzlement is because the movie industry has been this walled garden for many decades, seen as to valuable to peel back the layers to discover the crooks running the show.

In the past, what stopped folks from getting too uppety was buy offs. Most folks are pretty pragmatic, and will take 25% or 50% of what they're owed rather than going through the long, arduous and expensive process of actually moving a lawsuit all the way to the courtroom. I don't know whether the studios don't have as much money to buy off the people they've screwed, or whether some people, like Don Johnson, who just won $20 million bucks that he had been scammed out of over a similar deal for the Nash Bridges TV series are just saying "enough is enough", but if this becomes the rule, the MPAA's members are going to have bigger things to worry about than the Pirate Bay.

"In the past, what stopped folks from getting too uppety was buy offs. Most folks are pretty pragmatic, and will take 25% or 50% of what they're owed rather than going through the long, arduous and expensive process of actually moving a lawsuit all the way to the courtroom. "

Yeah, they've just delved too greedily and too deep. Someone might settle for half of what they're owed if the amount is tens or hundreds of thousands of dollars, but for tens or hundreds of millions of dollars, that years-long court battle might be worth it.

he only reason most of Hollywood's accountants and producers aren't rotting in jail for embezzlement is because the movie industry has been this walled garden for many decades, seen as to valuable to peel back the layers to discover the crooks running the show.

I'm not sure if the reason is some walled off garden. Remember McCarthy? There is a shinning example of what can go wrong if you start digging into Hollywood too deeply. They control the media more so then any politician or political group could eve

Honest people think most other people are honest, while thieves think everyone is a thief. If you see any kind of DRM on anything, you can be pretty sure its creator is a thief, and a stupid one at that.

Your reading comprehension is a bit flawed today. I didn't say that honest people thought everyone was honest; you only have to be ripped off once to know that not everyone is honest. Most people are honest, me included. But thieves think everyone is a thief.

In other words, as soon as everyone realized that a percentage of the net was for suckers and started insisting on a percentage of the gross, Hollywood re-defined 'gross' to be the same thing as 'net' and continued screwing people.

Forrest Gump: Oh, yes sir. Fucked me right in the buttocks. They said it was a million dollar contract, but the studio must keep that money 'cause I still haven't seen a nickel of that million dollars.

And Star Wars (4-6) - the guy who was actually in Darth Vader's suite never got paid for the role.

I mean, why should he? That freeloading bas**rd was just hanging around Vader's suite? Being such a key figure in the Empire, he's probably got his suite outfitted with all sorts of luxuries.
note: suite and not suit

Where have you been? It's been posted on Slashdot and elsewhere numerous time. Requiring a source for every claim is just being anal especially for something so easily verifiable by yourself with a google search.

Yes but there is demanding a source for something that sounds odd and then there is just being a dork and asking for sources for any claim in hopes they won't do it and thus their comment is deemed invalid and giving yourself some sort of self satisfaction.

and it bit them in the ass.
They successfully screwed over the author of the book the movie was based on.
Rumor has it that they wanted to film a sequel, but said author refused to allow it. As clearly there is no point in filming a sequel to an unprofitable film.

The producers of Forrest Gump used the same math to claim a loss on that one too

Winston Groom wrote the book "Forrest Gump" upon which the movie was based. As you suggest, he made very little money due to creative Hollywood accounting. When the producers approached him about making a movie off his sequel novel "Gump and Co." Groom apparently refused - Apparently he said something like "Why would you want to make a sequel when you lost so much money on the first movie?"

Ideally, no company should ever be allowed to bill a division of itself under any circumstances. Any staff employed by the company is already part of the normal operating cost of the company, and therefore, by definition, not an expense specific to any particular project. If a project would cause a division to be overworked and have to bring in more people, the correct answer is, "No," at which point the requesting division would have to decide if it was important enough to hire someone themselves. And i

Ideally, no company should ever be allowed to bill a division of itself under any circumstances.

No, internal billing has a place. It's an ingrained part of project accounting & isn't a problem as such. In most companies that are actually doing it, they charge exactly what it costs. You took 400 man hours of 'Research' time & we paid $30/hour for that time, we're billing you $12K which you can account for in your project budget.

The abusive companies are saying: You took 400 man hours of 'Research' t

It's the people below the poverty line who don't work and aren't productive enough that are to blame for Hollywood's plight. Not the rich accountants and brilliant producers that carefully select only the most qualifying of movies. It is obviously getting to the point where our culturual heritage -- the heritage of Americans -- in film needs to be conserved by the government. Which is why movies like Harry Potter should be able to apply for and be granted a government bailout when they finish in the red. It's obvious that the economy has hit them hard and they need a little help. With the file sharers and ripoff dupes in the world taking away their copyright, this is the only way we can help them out until a solid and sane prosecution framework like ACTA is approved for the whole world.

My thoughts and prayers are with Hollywood and the families of everyone involved with such quality original films.

Don't most major league sports teams do this as well? And major corporations in a bid to avoid taxes? And most (US) individuals in a bid to pay less in taxes?
I'm not saying it's right or wrong only that it just is and is practically universal.

No, this trick won't work for tax purposes. The IRS isn't that dumb (and when they are dumb it is never in your favor). The reason they are able to get away with it from a tax perspective is they actually do pay taxes on it.

What they are doing is setting up a separate corporation for each movie. The corporation is the one that makes contracts with the actors/directors/whoever. Then the studio charges the corporation a (bankrupting, in this case) amount for distributing the movie. Much more than actually distributing the movie cost, but of course the corporation pays it, and ends up making no profit on the movie. The studio still has to pay taxes.

Now, as an average person, you can try to do that, and set up your own personal corporation so you can deduct 'business expenses,' but the IRS will still make you pay a full amount. The studios also still have to pay the full amount in taxes, just not to other people (unless other people sue).

Studios will still continue to do this kind of thing, because while on highly profitable movies, juries might not favor them, on less profitable movies it will be easier to get away with. Obviously it is fraud, but I don't know if it is close enough to the legal definition to press legal charges.

Sure it's perfectly legal and moral to set up shell corporations. It's what you do with them that matters.

I do happen to know a little something about corporate accounting. I actually once recommended that a company be split into two captive parts. The reason was that it had highly profitable software half and a very unprofitable hardware sales half. Splitting the company in two had a legitimate purpose: it made it easier to sell the software business by making its value more clear. Eventually it was sold to a company that already had a hardware business and it's co-joined hardware twin simply folded. That was all completely above board.

In accounting you are constantly making up fictional "expenses", but they are offset by fictional income. You do this in order to make the financial performance of your various business structures more clear. What you CANNOT do is make up expenses to mask changes in owner's equity.

I know that stuff that looks like this happens all the time, and there are lots of borderline cases where legal corporations are created in order to take advantage of various angles in tax law. Many of those schemes are probably illegal, but are allowed de facto because nobody has the time to unravel them. That's why certain politicians always try to understaff the IRS. It's not to defend Joe Blow, who can't hide any significant income. It's to protect the guy who can play the "blind them with bullshit" game with armies of lawyers and accountants.

The situation is different for taxes (which are an exaction in which you have no say) and business deals (which are supposed to be negotiated in good faith). When you enter into a profit sharing contract, you can't take a chunk of revenue, move it from your left pocket to your right and call that an "expense". The proper name for that is "fraud". It doesn't matter how formally correct you make the transaction appear. Substance matters in accounting, and if the substance of a transaction is fraudulent, it's fraud.

In fact, that is the very essence of skillful fraud: to make that which is unconscionable seem superficially correct in every form. You can't pass a counterfeit bill and use "it's such a good copy it is indistinguishable from the real thing." You can't engage in a fraudulent transaction and say, "But all the incorporation papers, purchase orders and invoices are in order."

Hollywood is the only party (and the music industry) that screws over the people actually producing stuff by pulling this trick. Sure corps do it all the time, but they pay employees first, and generally employee pay is not tied to "net profits" of the company. Same goes for sports teams. Lebron James paycheck is not dependent on the team he plays for making money, its dependent on how well he and his agent negotiate his contract.

In hollywood and the music industry, not only do they get to dodge taxes with this trick, they also get to dodge paying their employees cause most of the contracts in LA are of a "% of net profits" mold... Thus, not only are they screwing over the government (why again do they have so much sway in DC??!!??) but they screw over regular working people and of course, high paid actors and musicians as well...

Lebron James paycheck is not dependent on the team he plays for making money, its dependent on how well he and his agent negotiate his contract.

That's not exactly true. The players unions in major sports negotiate with the owners of the league's teams to determine the total player compensation. This is the major thing that's keeping the NFL players and owners from reaching a new agreement -- the players want to see what portion of the revenues go to player salary, but the league is refusing to release the

Tax avoidance through expense maximization and income minimization is one thing; there are rules and if you break them you get penalized, up to an including prison.

In this case, though, the rules (GAAP) are much more flexible and in some cases they can write their own rules (contract language, business procedures) and the punishment at worst might be a fraud conviction but generally the punishment is getting sued and that has a high barrier to success, let alone initiation.

It also helps that the "product" of much of Hollywood doesn't have the kind of supply-and-product chain that manufacturing or other industry has. It has a lot of soft costs and a lot of human costs that can silently and flexibly siphon money from successful projects (consulting fees, personal services (AKA "hookers and blow"), promotional costs, legal fees).

This is a very old trick, and I can't understand why people still fall for it.

Winston Groom had to learn the hard way when his deal involved a percentage of the net profits from Forrest Gump. Unfortunately for Winston, Hollywood accounting always makes sure there isn't any net profits.

This is why the big actors and producers always ask for a percentage of the gross revenue.

But basically Jackson had a gross cut contract, and claimed that New Line sold some of the rights to things like DVD distribution to other Time Warner companies for lower than market value - which of course reduces their gross (and hence Jackson's cut).

I think they settled, but I didn't really follow it closely - it's a pretty obvious technique though bound to get you sued...

".....and not pay our actors, writers, staff their share of the profit-sharing contract, but if you are dishonest and download a DVD, then you'll get the equivalent of a life sentence in fines! Seems perfectly fair to us." - Motion Picture Association of America (MPAA) aka megacorp tyrants

I call this the "pull it out of your ass" expense. We have no idea where this number came from, and it's just large enough to wipe-out the profit. How convenient.

INVESTMENTNegative Costs and Advance - $315 billion

And why is the "interest" placed under expense? I've always thought of interest as income... very very odd accounting these Hollywood types have. "Arrogance and stupidity in the same package - how efficient of you."

Without debating the merits of pirating copyright material, I'd point out that the people who sign on the dotted line for "net" deals know exactly what they're getting, which is nothing -- writers, actors, directors and "staff" (of which I guess I'm one) sign their contracts with the advice of a lawyer and a manager, and all of these people know exactly what "defined net" is, and how it's defined is completely clear in the contract. We should respect contracts, right? I can assure you whoever is complaining about their deal in TFA isn't J.K. Rowling, she's getting gross points.

The only revenue sharing deals that ever pay off are "first-dollar gross" or "dollar breakeven" deals, where the money directly from the box office is split. Net deals have always been a fantasy -- it was true when Art Buckwald sued Paramount [wikipedia.org] over to Coming to America in 1990 and it's still true now. In this particular case of Harry Potter, what WB appears to have done is borrowed the money to make Order of the Phoenix at a high rate of interest, and is paying off its note so slowly that the negative cost [wikipedia.org] of the film keeps going up relative to the revenue. What isn't mentioned is that Warner Bros. probably borrowed the money from AOL Time-Warner, it's parent, in the first place.:)

I'd point out that the people who sign on the dotted line for "net" deals know exactly what they're getting, which is nothing -- writers, actors, directors and "staff" (of which I guess I'm one) sign their contracts with the advice of a lawyer and a manager, and all of these people know exactly what "defined net" is, and how it's defined is completely clear in the contract.

So what you're saying is that multiple parties willingly enter into an agreement, the following being the possible outcomes:

In other words, it's a contract deal where one of the parties has a comprehensive ability to screw you over if they so choose. Yeah, I suppose you're stupid if you sign such a deal, but that doesn't mean it's honest or that it should be legal to make such a deal.

I'd remind you that writers do get hundreds of thousands, if not millions of dollars to write screenplays up front, they aren't dependent on the kicker to put food on the table or live in their house in Laurel Canyon. The screwing-over happens unif

The show, all in, cost about $110 million to make. Each year of its
original run, we know it showed a profit because they TOLD us so. And
in one case, they actually showed us the figures. It's now been on the
air worldwide for ten years. There's been merchandise, syndication,
cable, books, you name it. The DVDs grossed roughly half a BILLION
dollars (and that was just after they put out S5, without all of the S5
sales in).
So what does my last profit statement say? We're $80 million in the
red.
Basically, by the terms of my contract, if a set on a WB movie burns
down in Botswana, they can charge it against B5's profits.

Even if they didn't tell them so, the fact that they kept the show in production is enough reason to believe they're making money on it.

The other thing is, if they're losing money and reporting profits to shareholders, then how in the World are their books matching? Wouldn't that be considered fraud or at least a violation of SEC rules? What about GAAP and FASB rules? Or are there exceptions for Hollywood and Government?

See, the head company makes money, but your contract is with the smaller company that was created. So in this case, you work for Babylon 5 Incorporated. Babylon 5 Inc lost money, tons of it, but they aren't publicly traded or owned. This smaller company is wholly owned by Warner, Fox, etc., who charge the Babylon 5 LLC tons of money for the show. Things like loans, distribution fees, advertising, etc. Warner then gets that money and reports that on their books to their shareholders, which are open, and everything works out quite nicely.

See, the head company makes money, but your contract is with the smaller company that was created. So in this case, you work for Babylon 5 Incorporated. Babylon 5 Inc lost money, tons of it, but they aren't publicly traded or owned. This smaller company is wholly owned by Warner, Fox, etc., who charge the Babylon 5 LLC tons of money for the show. Things like loans, distribution fees, advertising, etc. Warner then gets that money and reports that on their books to their shareholders, which are open, and everything works out quite nicely.

Sounds like another old system -- you were paid for your work, but you had to lease all the tools and your food and housing from the company. Your pay always ended up being a bit lower than those costs, but no matter, the company would keep loaning you the tools and housing... as long as you kept working.

But then again, I knew that was the situation going in...I saw thewriting on the wall (and the contract) from the git-go. I didn't dothis to build an empire, I wanted to tell this story...and that's worthmore than anything else.

And this is why there's so much dreck in the movies/TV. Who the hell wants to give away their best creative ideas to a bunch of corporate executives, and never recieve anything in return except for the chance to "tell a story"?

Kudos to JMS for doing so; I feel I should mail him some money directly, rather than buy the DVDs, however.

That post from JMS really bummed me out when I first read it since I bought all five seasons and all of the "made for TV movies" on DVD. Not a penny of my purchases went to anyone that poured their heart and soul into B5. Hollywood Accounting is one of the big reasons I don't have much sympathy for the studios crying that they're loosing trillions of dollars to piracy. If they can fudge the numbers so no one can get any residuals, they can fudge the numbers just as much to claim that rampant piracy is going to force them to close up shop and justify their lobbying for more ridiculous laws in their favor.

The document shown probably concerns net calculations for a deal with a writer. A Deadline comment said:

These are VERY high loads, but they are TYPICAL loads for writers, who very rarely receive "cash break" or "studio breakeven" type deals. To repeat, nothing has changed under the sun: the "net" deal articulated above is fairly standard for writers. Typically writers are compensated up-front with a kicker if a film is absurdly profitable. Writers rarely, if ever, get gross or "studio breakeven" or "cash breakeven" -- i.e., a share of the revenue from the first dollar of revenue, or a share of the profits from the first dollar of profits. When the studio cut the deal above with the writer, I can't imagine they told the writer: "Once we breakeven, you get paid! We all win!" They probably said to his agent/lawyer: "We'll give you the standard "net" kicker", which is exactly what he got.

I.e. the writer got paid on a fixed basis regardless of movie performance, with the "net kicker" that no one really expects to see (except maybe on "Avatar").

Note the document has nothing to do with taxes. That is a very different story.

The CEO of the company I worked for used this trick once. He was trying to get all the executives to take a temporary pay cut for one month. In order to do this he mentioned that he took no salary for the last 3 months. While this was technically true, the more overarching truth was more sinister. He had in fact shielded himself and his income from any downturn in the business by setting up a second corporation where he was the only owner, employee etc. This was a marketing company. Now the first company only got leads from Direct Mail. Guess what the second company did? Direct Mail Marketinig. So while he took no salary from the first company, he continued to get paid very well from the second company for something the first could not live without.

This reminds me of when I worked for Hitachi Power Tools (HPT). Beyond the confusing owner ship of the company ( X% is owned by Hitachi Koki which is Y% owned by Hitachi Group, etc.) and the five year rotation of executives fresh from Japan (once they get a handle on the US market, they're sent elsewhere and are replaced by someone with no knowledge of the US market), they had a very interesting accounting practice:

Every month the head finance/accounting guy spent a few days locked in his office to produce

I know people who work for consulting companies on precisely these type of internal, cross-border deals. Their task is to ensure that their internal transactions are "arm's length", or at market value. If you know something about it, the IRS will surely welcome a tip.

Oh, right. I'm taking money out of the hands of the starving artists. You know, the ones who aren't getting any money because their points were off the net and golly gee, the movie didn't make any money.

I love Disney strip-mining the world's fairy tales for ideas and then suing people for intellectual property infringements.

And it's pretty much standard too - just invest as much as you can in your future projects and you won't have to pay taxes or anything on it. I used to work at a company (.com startup) that did the same thing. Every year they invested a rough $2 million (net profit) in the development team (4 people) - eventually the development team became their own company so they just shifted funds back and forth (here you go 2 mil. to build this application, here you go 2 mil. for rent) - the developers kept the same desks, computers etc. I believe they off-shored a healthy profit as well.

Accountants are there to minimize profit that is shown externally. External profits are always bad. They require taxes and other payouts to external entities. Just as an example because they have the highest gross profits I know about, MS earned about 14 million the latest quarter, of which 11 million was gross profit. About two million of that was spent on research and 4 million on admin expenses and marketing. This is about 33% of gross profits on marketing and admin. As a percent of gross profit this is not excessive, but as percent of revenue it is highly excessive. Other companies might spend 10-20% of revenue. It is arguable that MS maximizes admin expenses to minimize profit. They put perks in minimize taxes and make them look less profitable. They do the same with research money that leads nowhere, i.e. the kin.

Years ago I read an interview with one of the cast members of the original Star Trek.
He said that the most creative writers were the finance guys who claimed that in 30 years of reruns that Star Trek has never made a profit.
(I think the interview was in the early 90's)
Unfortunately I do not recall who that was.

Once a thief, always a thief. Remember that Hollywood itself was created to escape Thomas Edison's patent enforcers. In California the land was cheap (at that time), the sun was usually shining (free lighting), and they were a very long way away from the east coast and Edison.

So this means I should pirate more movies, since my pirating isn't hurting their wallet as much as they claimed it was yes?

When pirating, you never took into consideration whether or not it would hurt anyone's wallet except your own, so continue pirating at your regular rate. If you ever get caught (unlikely) you can tell them falzer on Slashdot said it was OK.

Copyright infringement is illegal, but it may or may not be wrong. If he pirates a movie that he would never buy, or like a lot of people pirate it then buy it when he sees he's not getting ripped off buying it, what he's doing is still illegal, but it isn't wrong.

Adultery is legal in Illinois, but it's wrong. Smoking pot is illegal, but it isn't wrong. Don't confuse legal and illegal with right and wrong. There are a lot of legal ways to steal, but they're still wrong.